Definition of the Bear Market

Have you ever heard of “bears” or “bulls”, concepts often used in the stock market? In reality, used by traders, these two terms designate the situation of the stock market at a well-defined moment.

Currently, we are seeing an increase in the number of markets that have integrated the bear market. But so far, many people still don’t know what it is. And this is precisely the subject we are going to talk about in this article. In other words, we will define what the bear market is, see how it works and evaluate its impact on the stock market.

Bear market: definition

A bear market: what exactly is it?

In simpler terms, a bear market is none other than the period during which there is a drop in stock prices. In other words, this is a drop of up to -20% compared to the most recent peaks.

The declines in question reflect the negative mood of the market over a period. And in the majority of cases, they are the direct results of the declines we see in the market. We can also speak of a bear market in the case of a decline in the BEL 20 or the CAC 40, two stock market indices.

Otherwise, the bear market can also cause a drop in the price of raw materials for a period of more than 2 months. If you think the recession might be linked to the bear market, well, you’re right. This is one of the main reasons that can lead to bear markets.

Can we give a precise definition of what a bear market is?

Truth be told, there is no particular definition of what a bear market is. Generally, a bear market refers to a steady decline in the cost of stocks. For financial organizations, this represents a considerable drop of -20% in the stock market.

And as was mentioned previously, the bear market is often linked to a reversal of the economy, i.e. a recession. Which could lead to an increase in the unemployment rate. A bear market can then be identified if you know the business cycle in which the current economy finds itself.

If the latter is in a recovery phase, the bear market would be, in this specific case, improbable. Alternatively, if the business cycle is about to go through a bubble, it is likely that this could lead to a bear market. In this case, be careful! Evaluate the situation before investing in the stock market.

If we refer to the name of the bear market, it refers to how a bear attacks its prey. It will therefore make movements from top to bottom, unlike a bull which attacks from bottom to top.

How can we interpret a bear market?

When you look closely at stock prices, they represent trends in investors’ income. In other words, since the market is falling, this will in turn lead to a decline in the value of stocks.

On the part of investors, this will cause haste and fear which will subsequently constitute a decision to secure their shares. But in any case, stock market crashes will be inevitable.

Please note, however, that this -20% reduction does not apply to the universal market. This is therefore not a conventional definition of what a bear market is. Other parameters must be taken into account to secure your investment. In particular the behavior of other investors. And when the stock market enters a bear market, most investors want to avoid risks. This is why they tend to invest in gold or government bonds, safer and more profitable investments.

What are the elements that can lead to a bear market?

Several factors can lead to a bear market. For example, we can talk about a decline in the economy, or even a drop in the rate of the active population. Otherwise, the bear market can also be directly related to the limitation of GDP growth, the regression of productivity, and the weakening of business productivity.

Other parameters that can trigger a bear market: lack of investor confidence. A bad omen can then cause investors to sell their shares in an attempt to avoid losses. Moreover, the bear market can last up to several years. A period during which it is possible to recover the market, but which could cause a considerable drop in share costs.

There is also what we call the cyclical bear market. This is a decline in the market which is not related to the collapse of the economy. This can last up to a few months. The Covid-19 pandemic is an example that best illustrates a cyclical bear market. In 2020, March to be precise, the stock market entered a bear market. Consequences: an international stock market crash.

What would then be the direct consequences of a bear market?

Concretely, what will happen if the stock market enters a bear market? Several repercussions will be noted. From falling stock prices, to declining consumer confidence, to rising unemployment rates, to investors selling their shares for fear of losing their shares.

Falling stock prices

During the bear market phase, stock prices continue to fall. We will then be confronted with stock volatility which could lead to a considerable decline.

​Reduction in risk-taking for investors

When the cost of stocks falls, investors prefer to avoid risks. It is a psychology that will lead to the bear market taking control of the market. As a result, it is the bear market which will determine the forecasts for the coming months, or even the coming years.

​Increase in unemployment rate

When the bear market takes control of the stock market, it means that the economy is in free fall. At least, these two elements are interdependent. This will lead to an increase in the unemployment rate. On the business side, there is less recruitment. Some are even turning to laying off staff.

Fewer and fewer sales for businesses

When the time comes for the bear market, companies will have to face difficulties that could lead them to make fewer and fewer sales. This is particularly explained by the decline in consumer confidence. The latter in fact prefer to save instead of increasing their spending. This is to focus more on essential products. Consequently, if households reduce their purchases, for businesses, this is a synonym of an unfavorable situation. This logically leads to a loss.

​So what are the different phases of a bear market?

4 phases represent a bear market. First, there is a considerable rise in prices, followed by a fall in stock prices. Added to this is the arrival of speculators and the fall in prices.

​1ʳᵉ phase of the bear market

The first phase of a bear market is represented by a considerable increase in prices, subsequently leading to a feeling of confidence on the part of investors. On the other hand, the latter will leave the market and recover the gains they have acquired.

​2nd phase of the bear market

At the end of the 1st phase, stock prices will decline, as will productivity, activities and profits of companies. These are therefore the main signs that represent a fall in the economy. Moreover, we call these elements economic indicators which, before the bear market, were above average. And because of the bear market, they will fall and fall below the norm. This will lead to capitulation, that is to say that investors will panic and some will even leave the market.

​3rd phase of the bear market

The 3rd phase of the bear market is represented by the arrival of speculators. In reality, they are beginners who have just arrived on the market and who are increasing the volume as well as the price of exchanges.

​4th phase of the bear market

It is during the 4th phase that the decline in stock prices persists. The period will indeed be longer. For investors, falling prices represent an opportunity to get back into the market. And in this case, we are no longer talking about a bear market, but a bull market.

How to differentiate a bear market from a correction?

Obviously, a bear market is different from what we call a correction. We speak of a correction when it concerns a trend lasting no more than 60 days. This is then an opportunity, or even a favorable moment, to find an entry point into a bull market. On the other hand, we very rarely find entry points in a bear market. This is because it is almost difficult, if not impossible, to identify whether there is a gap in a bear market.

So, if you want to invest in the stock market, we do not recommend buying shares in a bear market. On the other hand, this can be done provided you use a strategy that can allow you to take advantage of bear markets, or even if you are a short seller.

​Do you want to face a bear market? Here’s how to do it!

The best way to react to a bear market is to short sell. In technical terms, this approach is called “short selling”. But how to do it ?

In reality, you can borrow shares and then sell them on the market. The next step is to buy them back at a more attractive price. Except that this method has a high failure rate.

To be able to borrow shares, you will need to use a broker. Subsequently, the sum of the deficit or profit will correspond to the difference between the sale price of the shares and the purchase price of the shares.

​End this article in style with a concrete example of a bear market

For example, you sold 100 shares short for a sum of 50 euros. When the period of falling prices comes, the shares will be covered up to 40 euros. In this case, your profits amount to 1,000 euros, or 10 euros per share. Here we are talking about the sale of 100 shares.

In case the stock price increases, the investor would have to buy the stock at a high price. This leads to a considerable loss. On the other hand, it is entirely possible to minimize risks to better cope with a bear market. To do this, consider reducing your number of growth stocks. Otherwise, it is also possible to turn to bonds which, in the event of a bear market, perform better. We are talking here about an investment in gold or an investment in the sectors of basic necessities, health, etc.